Economic Subsistence

Several weeks ago DOW 16,000 was a foregone conclusion…it was practically guaranteed. Now the DOW’s wildly spiking and diving above and below 15,000. What gives?

From what we gather, markets are anxious about what central bankers can and can’t do to suppress interest rates. After five plus years of a Fed funds rate at practically zero and 10 Year Treasury yields bumping along around 2 percent for the last 20 months, the feeling this can’t last forever has begun to set in. Alan Greenspan’s even talking about it.

Perhaps the economy is improving and no longer warrants all the monetary stimulus. Or maybe a mass devaluation is approaching. Regardless, rates must eventually rise. But what are the consequences?

No doubt, asset prices have been inflated by ultra-low rates. Take the housing market for instance. Low rates first cushioned the fall. Then they floated prices back up.

So what will happen when rates normalize to 4 – or even 6 – percent? Connecting the dots brings us to the very simple conclusion: when rates rise, prices will fall.

Sinking Back Underwater

But what do we know, anyway? We are merely looking at what’s going on and drawing a logical conclusion. Nonetheless, we’re not the only ones with this inkling. Peter Tchir of TF Market Advisors thinks so too…

‘“This whole housing recovery that we’ve seen over the past year has been at much lower rates, so we’re very concerned,”’ said Tchir on Tuesday.

Over the last five weeks 30-year fixed mortgage rates, which generally track 10 Year Treasury yields, have risen from 3.52 percent to 4.1 percent. From a practical standpoint, notes Tchir, “The recent increase adds $100 onto the monthly mortgage payment for the typical, $245,000 house.”

In other words, the typical buyer has three choices: (1) they can, somehow, figure out a way to afford a monthly payment that’s $100 higher; (2) they can lower their standard and buy a cozy fixer upper; or, (3) they can wait for housing prices to drop relative to the higher mortgage payments.

Our guess is that house buyers will do a combination of all three. And existing home owners, after briefly getting their nose above water this spring, will quickly sink back underwater. But it’s not just the housing market that’s impacted by rising rates…

Economic Subsistence

You see how it works. Central bankers, with their monetary intervention, distort markets. Good people, who are intelligent in every way, make decisions that at the time appear rational.

Then, next thing they know, the rug gets pulled out right from under them.

Of course, the Fed is only trying to make the world a better place. They’re just trying to improve the economy. Don’t you remember? Paul Krugman told us all debasing the currency would stimulate business.

“Raising the Fed’s inflation target to 4 percent from its current 2 percent, a taboo for many policymakers, would encourage households to spend and businesses to invest, generating more hiring and economic activity,” said Krugman one year ago.

Good grief. What a crock of horse pucky that’s turned out to be. The Fed added $3 trillion to its balance sheet and rather than an economic boom…we got an economy that subsists on ever increasing issuances of cheaper and cheaper credit. Cut it off and the price structure caves.

Contrary to what Krugman’s aggregate demand graphs said would happen the abundance of cheap credit didn’t produce an abundance of new jobs. Nor did it bring about prosperity for all in our time.

Instead the stimulus has pushed all of us out onto a precarious place…where there’s no turning back. It’s not a matter of if the rug will be pulled out from under us; but when.